Smart investing: Is it time to buy gold?

Gold doesn't pay interest or offer dividends, but investors have flocked to bullion in the last decade as stocks have tumbled. Is it the right time for you to buy gold?

Commentary

What asset has appreciated more than 300 percent since 2000?

It's not US stocks. The Standard & Poor's 500 index is down more than 20 percent from a decade ago. Emerging markets? Up less than 150 percent. Oil? Ditto.

The winning investment is gold. An ounce of the precious metal, worth $285 in mid-2000, was hitting record highs in June above $1,250.

Is this the time to jump on the gold bandwagon? Some people think so.

"Investors have come to embrace gold as part of their portfolios," says one New York authorized purchaser of coins from the United States Mint. He sees gold as a haven from the global and US economic turmoil.

And there are shiny new reasons to buy. In June, the US Mint began selling a 24-karat American Buffalo one-ounce coin in a fancy box, a Jane Pierce First Spouse half-ounce gold coin, and the 2010 American Eagle Gold Bullion Fraction Coins.

But to many investment advisers and economists, gold is a poor investment. It doesn't pay interest or offer dividends. The only way to make money on gold is "to find a bigger fool" to buy it from you, says Paul Kasriel, an economist with the Northern Trust Co. in Chicago.

If the goal is to avoid inflation, forget it, says Mr. Kasriel. "There really is not much inflation in the developed world." The US consumer price index declined 0.2 percent in May and is up only 2 percent versus a year ago.

Moreover, though the Federal Reserve is keeping short-term interest rates extremely low, the nation's money supply has been growing at less than a 2 percent annual rate. So, if the late economist Milton Friedman remains right that inflation is "a monetary phenomenon," the prospects for high inflation soon are low. "The risks are more toward deflation than inflation," says Kasriel.

Nevertheless, people are buying gold. The US Mint continues to do good business in the yellow metal. It had sold 521,000 ounces of precious-metal American Eagles and other gold coins this year through May, down only a little from 554,000 ounces for the same period in 2009.

The World Gold Council in London, representing the gold mining industry, sees strong demand for gold this year, supported by growing use of gold as jewelry in China and India as well as from continued economic instability, sovereign risk, and the threat of a "double dip" recession. Some commercial banks have been adding to their capacity to store physical gold for their customers.

In a way, the gold price is subject to the whims of central banks. They hold around one-fifth of the estimated 158,000 metric tons (174,200 short tons) of the world's gold stocks held above ground (i.e., not still in the earth). Gold prices were so low a decade ago because many central banks were trimming their reserves. Between 2002 and 2006, these monetary authorities sold an average of 527 metric tons per year.

But central banks, like other gold owners, don't want to see their golden asset clobbered. So last August, 18 European central banks agreed to limit annual sales to 400 metric tons for five years.

Since much of the above-ground gold can be easily sold or bought in the form of coins, bars, or jewelry, making a profit depends heavily on timing – catching a hard-to-predict upturn in price, notes Asha Bangalore, a colleague of Kasriel.

Hit it right, and you could earn 300 percent. Hit it wrong, and you could sit with the glittery metal, generating no revenue, for a long, long time.

•David R. Francis writes a weekly column.